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Why Are Retailers Giving Disappointing Earnings Outlooks?

American Eagle, Big Lots, and Five Below recently joined the group of retailers who gave gloomy fourth quarter guidance. Many retailers seem to be saying the same thing as Wal-Mart did in mid-November regarding the competitive retail environment. However, there are many other reasons why retailers are betting on disappointing fourth quarters - despite the upcoming holiday shopping season.

American Eagle(NYSE:AEO), Big Lots(NYSE:BIG), and Five Below(NASDAQ:FIVE) now joined other retailers this earnings season that reported dismal third quarters, downbeat fourth-quarter outlooks, or both of these. Most retailers seem to agree with what Wal-Mart's (NYSE:WMT) CEO, Mike Duke, stated in November about the retail environment remaining competitive amid economic uncertainty among customers. However, there are many other factors that explain why most retailers are giving disappointing earnings outlooks.

More downbeat earnings at American Eagle, Big Lots, and Five Below...

Retail Store

3rd Quarter Comp Sales YOY Change

3rd Quarter Net Income YOY Change

4th Quarter EPS Guidance vs. Analysts' Estimates

American Eagle

-5%

-68.3%

Below

Big Lots

-2.5%

-36.8%

Below

Five Below

+9%

+142.8%

Below

Source: 2013 3rd Quarter earnings reports .

Above are the third quarter year-over-year, or YOY, performance highlights as well as the guidance outlooks for American Eagle, Big Lots, and Five Below, respectively.

American Eagle's CEO, Robert Hanson, echoed other fashion retailers in recent weeks by saying that the continuous promotional landscape in this sector has been tough on profit margins. Unlike some peers, American Eagle was still able to generate positive income of $24.9 million for the quarter, although this was considerably less than its $78.6 million for the third quarter of 2012.

Big Lots' biggest problem this past quarter was announcing its departure from Canada. What started out as a strategy to compete globally with industry peers Target and Wal-Mart is now a big failure for Big Lots. As expected, fourth-quarter guidance is now below estimates. The real question is how long can Big Lots survive in this retail sector.

In contrast to American Eagle and Big Lots, Five Below actually had an excellent third quarter. For the year, Five Below's net income sits at $7.3 million, which compares to last year's total at this point of $0.8 million. Back in September, the company raised its full-year guidance. However, this past week its fourth-quarter guidance came in below analysts' estimates.

Why are retailers giving disappointing earnings outlooks?Are retailers sandbagging investors and analysts this holiday season? Were Wall Street estimates just too optimistic given how well the market has performed in the first three quarters of this year? It is highly unlikely that every retailer decided to low-ball estimates in the same quarter. Furthermore, while Wall Street has been very optimistic this year, some retailers like Five Below seem to have flipped their guidance from just a quarter ago.

First, the holiday span between Thanksgiving and Christmas this year will be the shortest since 2002, and six days shorter than last year. It may be too much to ask for consumers to compress their shopping time when holiday shopping is traditionally overly crowded to begin with. Speaking of crowds, or the lack thereof, weak store traffic has been blamed in earnings outlooks since people don't go out as much because of online shopping sites like Amazon.com.

By Anthony Bailey, via Wikimedia Commons

Online shopping has hurt margins for many retailers because consumers are now smarter than ever. Cash-back websites have helped consumers save more, and more recently, major credit card companies have joined the action by offering their own discounts for retailers. American Eagle is one of many clothing stores listed on cash-back websites.

Consumers are still cautious because of the mediocre job market, the lack of significant salary increases for those that are employed, and the higher cost of living. Any one of these factors would be a blow to retailers. Combined, they make fourth-quarter outlooks even more bleak.

Industry fragmentation has given customers more options than ever before at the expense of retailers' bottom lines. The promotional environment has created an infinite loop of sales in order to reduce inventories for new items which will eventually be also sold at reduced prices.

The new normal?Instead of spending money on small retail purchases, customers are now buying cars, houses, and going on vacations. Both Lowe'sand Home Depot raised their 2013 outlooks after their solid third-quarter numbers. Home construction has been a growing trend and it is expected to grow even faster in 2014.

Likewise, automakers reported another month of stronger sales in November.

Keith Jelinek, of AlixPartners, stated that discounts of 40% seem to be the new 20% when it comes to the ability to lure shoppers into stores. Combine this with the strong possibility that Black Fridays have now become Black Thursdays, which have cannibalized promotions typically sought after in December, the new normal may be a recipe of disaster for retailers.

Bottom lineUnless there is a strong shift in philosophy among retailers, discounts over the December holiday season will need to be even steeper than the ones seen during Thanksgiving weekend. American Eagle is still making a profit despite the intense promotional environment, but for how long? Big Lots has serious problems because it wasted over two years in Canada when it could have adapted its website to allow customers to order online. Lastly, while Five Below is still growing, retail history has repeatedly shown that nothing lasts forever.

Author

I graduated with honors with a B.S. in Mechanical Engineering from Virginia Tech and later got my MBA from the University of Pittsburgh. I'm a Licensed Professional Engineer (P.E.) for the state of Pennsylvania. As an experienced equities investor and Motley Fool member since 2006, I try to show that investing is not only for the pros. Follow @mikecart1